For many Americans, health insurance premiums can be one of the largest expenses to budget for each month.
As the cost of healthcare continues to rise, consumers are looking for ways to save on their premiums. One way to do this is by getting a tax break on your health insurance premiums.
However, getting tax savings on your health insurance premiums is a little different based on if you have a pre-tax premium or an after-tax premium.
In this article, we’ll discuss the tax deductibility of medical premiums—both pre- and after-tax—, and how these deductions can be used to your advantage.
What are pre-tax medical premiums?
First, let’s talk about pre-tax medical premiums. A pre-tax medical premium is a health insurance premium that’s deducted from your paycheck before any income taxes or payroll taxes are withheld and then paid to the insurance company.
You must be enrolled in your employer-sponsored health insurance plan in order to pay your premium with pre-tax money.
Employer-sponsored plans with qualifying pre-tax premiums include the following:
- Major medical coverage
- Supplemental/voluntary coverage
- Healthcare spending account contributions, such as health reimbursement arrangements (HRAs), health savings accounts (HSAs), and flexible spending accounts (FSAs), or HRAs, HSAs and FSAs
- Employer-sponsored reimbursements for medical premiums
You can confirm if your health premiums are pre-tax by viewing your pay stub and looking for a column titled “Deductions,” or something similar. If your health premium is in this column and is deducted from your gross pay, it’s a pre-tax premium.
Tax deductions for pre-tax premiums
There are a lot of advantages to having your premium deducted on a pre-tax basis from your paycheck. If your employer sets up a Premium Only Plan (POP), or Cafeteria Plan, your insurance premium contributions can be deducted from your payroll on a pre-tax basis. This plan can save you up to 40% on income taxes and payroll taxes. Also, pre-tax medical premiums are excluded from federal income tax, Social Security tax, Medicare tax and typically state and local income tax.
You can also reduce the amount of taxes that you owe with exclusions, deductions, or credits. These three subsidies are slightly different in nature but all boast big advantages. Essentially, deductions and exemptions both reduce your taxable income, while credits reduce your tax.
After-tax medical premiums
Next, let’s talk about after-tax medical premiums. If you don’t want to participate in your employer’s pre-tax plan, or if your employer doesn’t offer a pre-tax plan, you can elect to deduct your medical premiums on an after-tax basis.
Unless you have one of the eligible healthcare spending accounts, any copays, prescription costs, and payments you make before meeting your deductible are also considered after-tax medical expenses.
Individually purchased plans with qualifying after-tax premiums include:
- Major medical coverage, such as purchasing individual health insurance through the Health Insurance Marketplace
- Supplemental/voluntary coverage, such as accident or disability insurance
Coverage paid with after-tax dollars can be dropped at any time, so a good reason to go this route is if you anticipate dropping the coverage and enrolling in another plan in the middle of the year because you qualify for a special enrollment period.
Tax deductions for after-tax premiums
While different from pre-tax premiums, after-tax plans can still offer some savings. For example, you can still list premiums as an itemized deduction when you file your income taxes for all medical expenses and premiums that exceed 7.5% of your income. Additionally, most self-employed taxpayers (including owners) can deduct health insurance premiums using Schedule 1 for Line 16 on Form 1040.
If you paid your premiums with pre-tax dollars, you don’t qualify for this credit since you already received a tax break when your employer deducted your premium from your paycheck. The pre-tax option allows you to receive the full tax benefit because all of your premiums are tax-free.
HRAs deliver pre-tax benefits with after-tax flexibility
An HRA is an employer-funded, tax-advantaged benefit that allows both employees and employers to save on the cost of healthcare. Your employer sets aside a specific amount of pre-tax dollars for you to pay for your healthcare expenses on a monthly basis.
With an HRA, you purchase an individual health insurance plan with your own money, then your employer reimburses you for your premiums and other eligible out-of-pocket medical expenses up to the set allowance amount.
The reimbursements are made on a pre-tax basis, so you get the same tax benefits as you would with a traditional pre-tax plan. In other words, employees don’t need to claim an income tax deduction for an expense that has been reimbursed under the HRA.
What’s more, you’ll also get the benefits of an after-tax plan. You choose the exact plan you need from typically a larger selection than your employer might offer. You can drop the plan at any time and you can take it with you if you leave your employer. However, if you leave your employer, you lose your allowance because unlike an HSA, HRA funds stay with the employer.
If your insurance plan is employer-sponsored, you’ll be able to pay for premiums on a pre-tax basis, saving you money on income and payroll taxes. If you purchase your own individual plan, you’ll have more flexibility, but will pay more taxes. If you have an HRA, you can get the best of both worlds by selecting an insurance plan that works for you and receive an allowance for tax-free reimbursements.
If an HRA sounds like the right option for you, PeopleKeep can help you with that. Simply schedule a call with one of our personalized benefits advisors and we’ll help get you started.
This article was originally published November 6, 2020. It was last updated October 11, 2021.